With an apparently perfect sense of timing, Congress decided to stimulate the economy through fiscal policy the very week the Federal Reserve decided its extraordinary efforts to stimulate the economy probably weren’t needed anymore.
It sounds like some sort of coordinated policy, but that’s giving the Congress far too much credit. What it did was give final approval to a $1.8 trillion government spending and tax package that includes large amounts of money for popular programs as well as hundreds of billions of dollars of cuts to unpopular taxes.
So maybe it was just a coincidence, but consider what just happened:
For the Federal Reserve, this month brought to a close a period of doing pretty much everything it could, including flooding the financial system with money by buying a massive amount of government securities, to stimulate an economy that continued to climb very sluggishly out of a very painful recession.
Meanwhile, the federal government’s new spending and tax program effectively ended a fiscal policy that was also extraordinary, at least compared to what policymakers usually think to do in an economic slowdown. Until this big deal was approved the government had been in the hands of people who thought it was a good idea to curtail government spending after a terrible economic downturn.
It wasn’t just a blip in a long-term trend of spending growth, either. In inflation-adjusted terms, since peaking in 2009, government spending actually had been declining for five years before plateauing a bit more recently.
It’s no wonder former Federal Reserve Chairman Ben Bernanke used to complain all the time about the Federal Reserve’s having to fight the “fiscal headwinds” putting a drag on the economy.
His message was that the Fed wouldn’t have had to do the extraordinary things it did to try to get the economy moving had Congress only figured out that just after the worst recession in 75 years was maybe the wrong time to try cutting back on spending.
When Janet Yellen took over the job she picked up where Bernanke left off. She, too, complained of fiscal headwinds as one of the drags on the economy.
It’s no surprise the central bankers cared a lot about how much the government planned to spend, because it’s a big player in the American economy, most recently about a fifth of gross domestic product, the basic measure of the overall economy’s size.
That’s why cutting back on government spending is not the smartest call when the economy is slumping. Why make things worse?
This appears to be a counterintuitive idea for a lot of people, including some elected to public office. After all, downturns in the economy force business executives and families to cut back on what they spend, lest they risk running out of money. State and local governments generally have to do that, too.
The federal government doesn’t have to act that way, not with its ability to easily borrow money at very low interest rates. In a worst case, it can power up the printing presses and print more money to pay its bills, although there can be terrible consequences down the road from doing that.
Because the federal government is in a position to spend its way through a downturn, it’s in a position to help the economy when businesses and consumers have turned cautious. Some aspects of government spending even work to prop up the economy more or less automatically, such as when checks get issued for unemployment benefits.
In the past five years a lot of the political rhetoric seemed to point to an opposite conclusion about the economic impact of government spending.
Managing a surging federal debt load is a legitimate concern, but to knock government spending at a time of sluggish growth and high unemployment is a little like complaining that it’s been too rainy to set up the sprinklers to water the front lawn.
The government did have to borrow more money to sustain the spending it did since the Great Recession, even though the annual deficits have also been declining steadily. In the fiscal year that ended Sept. 30, the deficit was down 9 percent from the prior year to $439 billion, or around 2.5 percent of gross domestic product.
That last measure is a very telling one, the government deficit as a percentage of our overall economy. It’s declined sharply since 2009, and most recently that deficit as a percentage of GDP has been far lower than the average of the last 40 years, lower even than in the economic boom years of the 1980s.
From what can be gleaned from the news coverage of what just got passed by Congress, there is a turnaround coming in the deficits, and that number is about to start inching back up.
In observing Washington from 1,100 miles away, it’s not clear why the Congress has given up its effort to rein in spending now, after the unemployment rate has been cut in half from its postrecession peak of 10 percent back in 2009. It looked like a bipartisan effort, too, as both parties saw a chance to agree on a package that increased spending for some of their favorite things after years of partisan wrangling.
When it comes to economic policy, though, there’s little reason to have any hope that this time our elected representatives in Washington have gotten it right.